Life insurance can seem like an intimidating concept when you first get started, but it’s really not all that difficult with a little help.
When you have a life insurance policy and pay your premiums on time, the insurance company will issue a death benefit when you die.
Where does the death benefit go?
The answer to your life insurance beneficiary.
Within your policy, you must designate someone to collect the death benefit proceeds if you were to pass away. In most cases, this would be your significant other or someone close to you that relies on you financially.
If you don’t name a beneficiary to your life insurance policy, you run the risk of having the death benefit being paid directly to the estate. Although this may not necessarily be viewed as a bad thing, for some, it could end up becoming a complete mess for your surviving family members to sort out after you’re gone.
While choosing a beneficiary is just one part of the overall process of getting life insurance, it is one of the most important parts of having a policy. Let’s take a closer look and what the role of a beneficiary is and how exactly you should go about choosing one.
Here’s everything you need to know about a life insurance beneficiary.
Definition of a Life Insurance Beneficiary
One of the first questions you may have regarding life insurance is “what’s a life insurance beneficiary?”
The beneficiary is the person or in some cases the entity that will receive the death benefit proceeds of the life insurance policy when the insured individual has passed away.
When applying for life insurance coverage you will be required to complete an application for coverage. Often, located within the first part of the application will be a section in which you will be required to name who will be your beneficiary.
You can name a single person or even multiple persons. You can even choose to name a trust, your church or a charity of your choosing. If you don’t have a beneficiary in mind, you can always choose to leave the proceeds to be paid directly to your estate. But either way you will be required to complete the beneficiary section of the application, it cannot be left blank.
What Is The Purpose of a Beneficiary?
The beneficiary is one of the main components that make up a life insurance policy. It’s also safe to say that it’s likely the main reason why you might be buying life insurance coverage in the first place.
When you purchase a life insurance policy you choose a type of coverage (term or permanent), determine an appropriate amount of coverage (known as the death benefit), and name a beneficiary (the person that receives the death benefit).
The purpose of naming a beneficiary ensures that that individual or individuals listed as the beneficiary will be able to receive the death benefit proceeds efficiently so that they do not experience a lapse in finances.
Why is this important?
Losing a loved one is not only emotionally devastating but it will often have a significant financial impact on a family. Immediate expenses such as funeral costs and other household bills associated with a loved one’s death will require the attention of the surviving family members.
In addition to the immediate financial needs that death can pose on a family, your surviving family members will also have long-term needs such as daily living expenses, household bills, and child care should there be children involved.
The death benefit that a life insurance policy provides can help the surviving family members pay for the expenses related to your passing as well as have the funds to continue maintaining their standard of living. To ensure that the money goes to the party you desire, you must name a beneficiary.
Key reasons you need a beneficiary:
- Speed up the process – Naming beneficiaries in your life insurance policy will help ensure that the beneficiary will receive the funds they need promptly. It speeds up the process, shortening any time in probate court, and reduces legal complications. The payout from your policy can happen quicker, giving your beneficiary access to the funds shortly after the company has processed the death claim.
- Clarity – Grief can make situations very tense, which may lead to disputes among families. Naming beneficiaries makes it very clear what your wishes are and binds them legally. This helps keep the peace among your loved ones and ensures that your intentions are clear.
- Control of death benefit proceeds – Naming beneficiaries gives you complete control of where the financial funds will go and who gets access to it.
How many beneficiaries can you list on a life insurance policy?
There is generally not a limitation on the number of beneficiaries you can name on a life insurance policy. Having multiple beneficiaries is actually more common than you may think.
For example, you may choose to name your spouse, children, and even a senior parent as beneficiaries on your life insurance policy.
If you choose to have multiple life insurance beneficiaries, you will be required to divide how the total death benefit will be split among all named beneficiaries in whatever way you choose.
Death benefit proceeds are generally split in percentages rather than whole dollar amounts when completing the life insurance application. If there are multiple beneficiaries, the death benefit must be divided among individuals with a total percentage equal to 100% of the death benefit.
|Beneficiary Designations - Must Equal 100%|
In short, you can name several beneficiaries on your life insurance policy but keep in mind that the more beneficiaries you name, the smaller percentage of the death benefit they can each get.
For that reason, you should be mindful of how many beneficiaries you select and focus on choosing the most relevant beneficiaries and what type of financial impact they will endure due to your passing.
Types of Life Insurance Beneficiaries
Not all life insurance beneficiaries are the same.
If we circle back to the life insurance application, you’re going to notice that there are two main types of beneficiaries listed on the life insurance application, and they include a primary beneficiary and contingent beneficiary.
It is important to know the difference between the two and how they differ from each other.
What is a primary beneficiary?
A primary beneficiary is the main individual or individuals that would receive the death benefit payout of the insured’s life insurance policy. Should the insured pass away while the life insurance contract is active, the primary beneficiary is often tasked with contacting the insurance company to start the claim process.
When the insurance company has completed the claim process, a lump sum payment, often in the form of a check, will be paid to each primary beneficiary named within the life insurance policy.
A life insurance policy’s death benefit cannot be paid from the life insurance company to anyone other than the primary beneficiary unless the primary beneficiary has passed away. If this were to happen, the payment would be paid to a contingent beneficiary should one be named.
What is a contingent beneficiary?
A contingent beneficiary is a secondary backup to the primary beneficiary. The contingent beneficiary would receive the death benefit proceeds should the primary beneficiary become deceased.
For example, if the primary beneficiary has passed away simultaneously with the insured, the contingent beneficiary would receive the full death benefit proceeds.
The same could also be said should the primary beneficiary pass away, and the insured had forgotten to name a primary replacement beneficiary before their own passing. If this were to occur, the contingent beneficiary would receive the full death benefit payment.
Are you required to have a contingent beneficiary?
Naming a contingent beneficiary is not required, but it does offer the benefit in avoidinging unnecessary conflict and confusion among your surviving family members should your primary beneficiary become deceased.
What is a tertiary beneficiary?
There is also a tertiary beneficiary option in addition to the two main types of beneficiaries (primary and contingent beneficiaries). The tertiary beneficiary is a third beneficiary and would be the next in line to receive the death benefit if both the primary and contingent beneficiaries were to pass away at the same time.
As with the contingent beneficiary, the tertiary beneficiary is not required to have but can provide a sound structure of how death benefit proceeds should be paid out if the insured passes away.
If you choose to add a tertiary beneficiary to your life insurance policy, you will need to request this option as it is not a beneficiary found on a life insurance application.
Who Is Eligible to be a Life Insurance Beneficiary?
Before choosing a beneficiary, you will need to know who is and who is not eligible to be a beneficiary on a life insurance policy. During the application process, life insurance companies will look for an insurable interest connection between the insured and the beneficiary.
Insurable interest means that your beneficiary would suffer from a financial loss as a direct result of your death.
If there is no means of insurable interest in which the named beneficiary would not suffer a direct financial impact due to your death, it is highly unlikely that that person will qualify as a beneficiary.
Below is a helpful list as to which beneficiaries would meet the insurable interest guidelines and those who would not meet insurable interest.
Beneficiaries that meet Insurable Interest Guidelines
- Spouse – Insurable interest is rarely a question when naming a spouse as a primary beneficiary. In fact, if you’re purchasing life insurance and your spouse is not listed as a primary beneficiary, there is a good chance that you be required to provide a reason as to why you’re naming your significant other as your primary beneficiary. In some states (AZ, CA, ID, LA, NV, NM, TX, WA & WI), there are community property laws that require your spouse’s consent to name a beneficiary other than them.
- Ex-Spouses – Naming an ex-spouse as a primary beneficiary is a common qualification for insurable interest. Divorces that involve minor children will often result in court-ordered life insurance that makes sure that if the insured passes away, the ex-spouse will have the necessary funds needed to raise the children.
- Children – Naming a child as a beneficiary does qualify for insurable interest, but it should be done with caution. Death benefit proceeds are not paid directly to a minor. The death benefit proceeds are generally paid into a trust in which a court-appointed guardian would have access to the funds to help raise the child. Parents often want to name their children as contingent beneficiaries of their life insurance policy. If you choose to do this, we recommend creating a trust or a will with clear instructions on how the death benefit proceeds should be handled after your passing and until your child has reached the legal age to gain access to the death benefit proceeds. It’s best to speak with an attorney to set up the best arrangement for your situation.
- Domestic Partnerships – A domestic partner may qualify as a beneficiary provided there is a strong case of insurable interest such as owning a home together. The same applies to couples who are currently engaged and rely on each other financially.
- Elderly Parents – Adult children who would like to name their elderly parents as a beneficiary may be allowed as long financial justification can be made. As our parents get into their senior years, it’s not uncommon for them to rely on their children’s financial help. A couple of good examples would include an adult child making payments towards their parent’s long-term care assistance. Another example would be a widowed parent with young children that, due to their passing, the elder parent would raise the children.
- Charities & Churches – Want to help out your favorite charity or place of worship? Life insurance companies will allow both charities and churches to be named as a life insurance beneficiary without any question of insurability.
- Trusts – Setting up a trust and naming it as a beneficiary of a life insurance policy is perfectly fine. Trusts, both revocable and irrevocable, are helpful tools for estate planning needs and therefore meet the insurable interest guidelines of a life insurance beneficiary.
Gray Area Beneficiaries
A gray area beneficiary is a term we use for beneficiaries that may meet the insurable interest but should be done cautiously.
- Banks – Naming a bank as your beneficiary would generally occur when a business requests a small business loan (SBA) or some other type of business loan. Rather than naming the bank or lender as a direct beneficiary, a safer way is through a collateral assignment. The collateral assignment option allows the insured to name their loved one as the primary beneficiary and collaterally assign the loan lender as the assignee. Should the insured pass, the lender would receive the loan debt’s balance, and the primary beneficiary would be paid any remaining death benefit proceeds.
- Funeral Homes – According to the National Funeral Directors Association (NFDA), the national medical cost of a funeral with viewing and burial averaged $7,640. Add a vault and that cost increases to an average of $9,135. That is a lot of money for anyone to pay, especially when it is put on the deceased’s family members. A popular option that can eliminate this potential financial burden is with a pre-paid funeral plan. By utilizing a life insurance policy such as a small burial insurance plan, the death benefit proceeds can be paid to the funeral home to pay for the entire funeral cost. Pre-paid funeral plans can work by naming the funeral home as the beneficiary. Insurance companies will allow funeral homes to be named a beneficiary. A better option would be to work with a funeral home that is ok with accepting a collateral assignment of the policy while keeping a family member as the main beneficiary.
- Friends – In most cases, you will not be able to list a friend as a beneficiary of a life insurance policy unless there is significant evidence that your death would have a financial impact that would negatively affect them due to your passing.
- Non-Immediate Family Members – Naming a family member as a life insurance beneficiary is not an issue but can cause questions if it is not an immediate family member. As long as there is financial justification in naming a non-immediate family member as a primary beneficiary, it should not be an issue.
- Pets – It’s not often to receive a request to name a pet as a life insurance beneficiary, but it is an option that can be done. Since a pet cannot receive a death benefit directly, it must be done utilizing a pet trust. The pet trust would require the insured to name someone who would have guardianship to the pet and allowed access to the death benefit proceeds to help take care of the pet.
Who Would Not Qualify to be a Life Insurance Beneficiary?
If you’re wondering who would not be eligible to be named as a life insurance beneficiary, you have to look at whether or not there is an insurable interest. You have to ask yourself, would this individual suffer a direct financial impact due to my death?
If they don’t, then it’s highly unlikely underwriting will allow your choice to go through, or at most, you will need to make a strong argument justifying the insurable interest.
On the other hand, once a life insurance policy has gone through underwriting and coverage has been approved and actively placed in-forced with the insurance company, there are generally minimal restrictions to who you choose to name as your beneficiary, but this depends on the insurance company you have your coverage with.
Wills vs. Life Insurance Beneficiary
A will is a legal document that specifies how your assets would be handled after your passing. Generally, you name an executor of the will who would be in charge of making sure that your final wishes are carried out as planned. A will can also appoint guardians for both minor children and even pets.
A life insurance policy and a will are different in several ways, but they share a similarity in that they both require instruction from the owner for a plan to be carried out.
For life insurance, it’s the instruction to the insurance company on how and who the death benefits proceeds of the life insurance policy should be paid upon the insured’s death.
With a will, it’s the instructions on how the will’s creator would want their assets handled after their passing.
When it comes to life insurance beneficiaries and wills, insurance companies pay the death benefit proceeds according to what is designated on the beneficiary form. They do not pay the proceeds to the will, nor does a will trump a beneficiary designation form.
It is important that if you have a will and designated how your life insurance policy proceeds would be split upon your death, that those last wishes match what is on file with the insurance company. Ensuring that you do this will save your loved ones a lot of stress, heartache and possibly legal battles fighting over your death benefit proceeds after your passing.
Can an executor of a will be a beneficiary?
The executor of the will is your representative, and your beneficiaries are the parties you want to inherit the assets through your will. When you die, the executor must administer your will. You can have a beneficiary be the executor of your will.
It’s fairly common for a will’s executor also to be a beneficiary. It may allow the executor to do their duties better when they are very familiar with the decedent’s situation. As you might imagine, there are also cases where it makes more sense to name an executor that does not have a beneficial interest in the estate.
Things to Think About When Choosing a Life Insurance Beneficiary
Choosing a life insurance beneficiary is a very personal decision that will depend on your unique situation. It often helps to think about the people that rely on you financially.
When choosing a beneficiary, you should consider:
- Is there a qualifying insurable interest?
- Who is currently depending on your financial help?
- If your children are minors and you want to list them as beneficiaries, who will be the guardian of their money until they are of legal age?
- Should you place any conditions on when your children receive assets? It’s common for people to delegate a certain amount of money at 18, again after graduating from college, and then again after age 25.
- Do you want to support any nonprofits or charities?
Each person will have a unique goal for their policy and life circumstances. Many people buy life insurance to provide financial security for their families. In that case, it makes sense to name a spouse, children, or immediate family as beneficiaries depending on your family dynamics.
What information is needed when choosing a beneficiary?
A lot of what information will be needed when filling out a beneficiary form will depend on the insurance company you apply for coverage with. The majority of beneficiary forms will require the following information:
- Beneficiary Name (First & Last)
- Relationship to Proposed Insured
- Telephone Number
- Percent of Death Benefit Payout
If you choose to name a trust as your beneficiary, be prepared to include the date of the trust. Some companies may also require the first page and signature pages of the trust, which will be held on file.
Is Beneficiary Notification Required?
Notifying a beneficiary of a life insurance policy is not required by any means. However, it’s not a bad idea to give these people notification, so there is no delay in the death claim processing should the unthinkable occur.
To notify someone that they have been named a beneficiary, you can let them know verbally or better, provide them with a policy summary statement.
The policy summary statement can be obtained from the insurance company or if you have an online account with the insurance provider you should be able to print a copy of the statement online.
Your policy summary statement provides a quick view outlining the overall insurance coverage to include the names of the beneficiaries.
Changing a Beneficiary
Life changes and factors such as divorce, remarriage, or death can alter the dynamic of the beneficiaries on your policy. For that reason, many people want to know if they are stuck with the originally named beneficiary, or can a beneficiary be changed?
Yes, you can change the beneficiaries on your life insurance policy. The key is just remembering to do it as soon as you believe a beneficiary change should be required. To make a beneficiary change, you will need to contact your insurance agent or the insurance company to request a change of beneficiary form.
Most insurance companies that offer their customers online access to their policy will generally have the ability to make a beneficiary change online.
You want to make sure that your beneficiaries are in alignment with your current life situations. If your life circumstances significantly change, it makes sense to update your beneficiaries.
How often can a beneficiary be changed?
You will need to check with your policy to find out restrictions on how often you can change beneficiaries on your policy.
For example, the 529 plan allows you to re-assign the beneficiary up to twice a year. In most cases, there is not limit on the number of times it can be changed.
The process is generally very quick and easy, but you should be mindful of why and how often you change your beneficiary.
Will Beneficiaries Be Required to Pay Death Benefit Taxes?
Taxes can significantly change the amount of money you have. When trying to ensure that your beneficiaries will receive the death benefit proceeds they’re assigned, you may wonder, will a beneficiary be required to pay taxes from money received from a life insurance policy payout?
According to the IRS, “life insurance proceeds you receive as a beneficiary due to the death of the insured person, aren’t includable in gross income and you don’t have to report them.”
The beneficiaries of your life insurance policy will not need to report the assets as gross income. However, if they receive any interest from the time the death benefit is issued and paid to the insured, they have to include that as interest received and pay taxes on it.
Fast, Simple Life Insurance
While the idea of starting your life insurance policy and naming your beneficiaries may seem overwhelming at first, you can see that the process does not have to be a headache.
Once you have your life insurance policy, you should make sure to name primary and conditional beneficiaries that make the most sense for your unique situation.
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